Would you like to invest in cutting-edge technology businesses while they are still in their start-up stages? If you don’t have enough capital to spread among dozens of qualified candidates, or a team of experienced analysts who can help you recognize potential winners, you would be more likely to lose your shirt by putting your money into such businesses than to realize significant gains over the long run.
Lending to tech start-ups is far too risky for individual investors, but not for an organization like Hercules Capital (NYSE: HTGC). This business development company (BDC) sports a portfolio worth about $3.6 billion spread among dozens of different borrowers.
This makes the company a straightforward way for retail investors to gain exposure to the sort of investments that are generally limited to institutional investors and the wealthy. Surprisingly, billionaires who have enough resources to start BDCs themselves are adding this stock to the portfolios they manage.
In the first quarter, Ken Griffin more than doubled Citadel Advisors’ stake in Hercules Capital by acquiring 274,071 shares. David Siegel and John Overdeck of Two Sigma Investments opened a new position with 271,569 shares. Israel Englander and Millennium Management also opened a new position with 92,184 shares.
Why billionaires keep buying Hercules Capital
Hercules generally lends sums between $25 million and $100 million to start-ups in a variety of industries. The majority of its investments are in companies that develop software, and medicines.
Many of its investments fizzle out, but the ones that succeed more than offset its losers. For example, Hercules Capital was an early investor in Palantir, Axsome Therapeutics, and TransMedics Group.
The stock has outperformed the benchmark S&P 500 index by more than 50 percentage points over the past decade, delivering a 292% total return. With dozens of portfolio companies that could become multibillion-dollar businesses, it’s not hard to imagine this stock continuing to outperform in the decade ahead, too.
Hercules isn’t the only BDC funding high-tech start-ups, but it’s the only one I know of that also has investment-grade credit ratings from multiple agencies. In other words, it can earn more than its competitors while offering competitive rates that attract the best borrowers. After nearly 20 years in business, the contacts its underwriting team have built are another durable (albeit unquantifiable) advantage.
What investors can expect
All BDCs must distribute at least 90% of their profits each year as dividends, but Hercules Capital’s cash flows are lumpier than a cold bowl of oatmeal. That’s because it makes a lot of structured debt investments such as warrants that can turn small amounts of capital into heaps of equity once a portfolio company completes its initial public offering (IPO). Unfortunately, the timing of such events depends on factors that the BDC can’t control.
To compensate for those lumpy cash flows, Hercules distributes a standard quarterly dividend that it boosted steadily from $0.20 per share in 2010, to the $0.40 per share payment it sent out recently. The company also declares supplemental quarterly dividends, the latest of which equaled $0.08 per share.
If Hercules’ next supplemental payment is in line with the last one, investors who buy the stock at recent prices will realize a juicy 9.8% dividend yield. If the stock market doesn’t cooperate, Hercules portfolio investors who buy at recent prices could still receive a yield above 8% from the standard quarterly payout.
Appropriate for most
If you aren’t already in a position where you are on course to retire comfortably, you shouldn’t be lending money to software start-ups and clinical-stage drug developers. However, while the companies Hercules invests in are generally inappropriate for nearly all retail investors, the BDC’s long-term portfolio approach delivers fairly reliable cash flows.
Since 2020, Hercules has delivered returns that exceeded its peer group by a wide margin. With enduring advantages over its competitors, the next several years could be even more lucrative. Buying the stock now seems like a great choice for most income-seeking investors.
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Cory Renauer has positions in Axsome Therapeutics and TransMedics Group. The Motley Fool has positions in and recommends Axsome Therapeutics, Palantir Technologies, and TransMedics Group. The Motley Fool has a disclosure policy.
Billionaires Are Buying Hercules Capital Left and Right. Is the High-Yield Dividend Stock Right for Your Portfolio? was originally published by The Motley Fool